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Hotel owners and operators have their banks over a barrel

FEW industries are as adept as hotels at providing tempting offers—a well-stocked minibar, for instance—that lead to regret the next day. Lenders to the industry are now firmly in the regret phase. Over the next year banks in Europe and America may be forced to write down billions in bad loans, further impairing already strained balance-sheets. In many cases they are also likely to become the proprietors of debt-ridden hotels.

It is difficult to determine exactly how much outstanding commercial-property debt was used to finance hotels. But if commercial property has long been seen as the next shoe to drop in financial markets, hotels are the steel toecap. “There is a vast wall of properties out there that is underwater,” says Paul Bartrop of CB Richard Ellis, a property consultancy.

Data tracked by Moody's, a rating agency, on commercial mortgage-backed securities (CMBS) in America show that more than 10% of hotel loans were delinquent in February. That was almost double the average for commercial property as a whole. Loans for hotels are souring even faster in an industry index called the CMBX.5, which tracks more recent deals (see chart).

A large number of properties are being kept on life support by their owners. On March 7th Harrah's, a casino group owned by private-equity firms, reached a deal with its bankers to stop making payments until 2015. Blackstone, a private-equity firm, agreed last month to inject $800m in additional equity into Hilton Hotels and to buy back some its debt at a discount. Blackstone had paid $26 billion for the hotel group during the boom. Among the owners of Hilton's debt is the Federal Reserve, which took over loans that had been granted to the firm by Bear Stearns, a failed investment bank.

Others, however, are pulling the plug. In December the W hotel in Union Square in Manhattan, which had been bought for $282m by an arm of Dubai World, was sold at auction to one of its debtholders for $2m. In Britain Lloyds Banking Group this month swapped almost $1 billion in debt into shares in the Alternative Hotel Group. “Whether banks take [legal] control of the assets or not, there has been a shift of control from the owner to the lender,” says Kirk Kinsell of InterContinental Hotels. “We will be in for a long period when they will be the reluctant owners.”

There are two main reasons why hotel loans are so troubled. The first is that in many cases they were taken out by investors who need steady cash flows to repay debt, or were financed using instruments such as CMBS that also require steady income streams. Yet unlike office blocks or shopping malls, which sign leases with tenants for ten years or more, hotels have to let their rooms by the night. The revenue earned for each room (an industry measure of room rates and occupancy) fell by almost 17% in America last year.

The second reason is that lenders signed especially generous contracts with hotel owners and operators, which in many cases allow them to throw in the keys without the banks having recourse to their other assets. In a particularly galling case, Sunstone Hotel Investors, a real-estate investment trust in California, said it had decided to stop “subsidising” debt payments on $300m of debt and would give 13 hotels to its bank. Just days later it told its investors that it was looking at opportunities to buy hotels at a discount.